Venture Firms Fret as Y Combinator Soars
news.genius.comY Combinator is in itself a venture capital firm whose genius has been to use innovative ways to capture and control deal flow for premiere startup ventures.
Back in the day, top VCs would not be caught dead investing in an early stage seed funding. It was considered undignified. These were the firms that managed the best IPOs, that spawned the greatest tech ventures, that brought a value-add to their portfolio companies that was beyond measure as they would bring their formidable network of contacts into play for the benefit of their companies. And in return for their conferring such benefits on the ventures they expected to control things, or at least to have a formidable say in how things went. Yes, at the time of a successful IPO, they would convert to common stock just like the rest of the equity holders (though even there usually with the privilege of exercising registration rights) but before that they could and would exert liquidation preferences, conversion privileges, and control mechanisms in ways that left no doubt that they had the final say on most everything. And, if their interests clashed with those of the founders, it was not the investors who suffered. Top VCs valued their reputations and would tend to play it straight in not engaging in overt founder abuse. Yet the institutional mechanisms often gave them overwhelming leverage that left founders at a severe disadvantage: 2x, 3x, or higher liquidation preferences, full ratchet conversion adjustments on down rounds, etc. Lower-tier VCs went further and engaged in overt abuse on some occasions, to the point where the name "VC" often would make founders shudder.
Before YC, the only investors who actually took only common stock for their money were unsophisticated friends and family investors who didn't even know what preferred stock was. When YC came along, it took only common stock for its investment. Investors historically would look for ways to gain clout and squeeze founders through tactics such as 2x or 3x liquidation preferences in preferred stock rights, through lopsided conversion privileges used to wipe out founder interests in down rounds, through control tactics by which founders were put in defenseless positions and booted only to have the bulk of their founders' stock bought back at forfeiture rates, etc., etc. The persons being abused in such cases were primarily founders but the tactics wound up destroying or seriously compromising the interests of anyone who held common stock in such a venture. That sort of thing could prove very effective from an investor perspective when founders had no choice but to submit if they wanted the investors' money.
So founders basically had to come hat in hand to the VCs and play the game strictly by their rules, which amounted to the rules of a stacked deck. There is nothing inherently wrong with this. Money does indeed talk and, if founders wanted to take several million dollars as an investment from someone, they did what was needed to satisfy the investor requirements as they found them.
Y Combinator is an "accelerator" and all of that but what it mainly is is a VC firm that made the critical decision to align its interests with those of the founders right from the start.
So, out the window went the idea that a dignified VC would not soil its hands with a seed-stage investment. YC invested right from the start.
Out the window went the idea that a VC would take only preferred stock for its interest. YC took only common.
Out the window went the idea that a VC had to control the board, or at least had to have shared control, or at a minimum at least one board seat. YC left the board in the hands of the founders.
These innovations by themselves would likely have changed nothing but YC also built an incredible following of top founders inspired by Paul Graham and others who sought to build a network structure characterized by the highest level of talent. This too worked and YC companies thus got access to a rich treasure trove of resources that gave a value-add far exceeding that offered by a traditional VC firm. This in turn established YC as an omnium gatherum of much of what was and is best in the startup world.
With its interests largely aligned with the interests of founders, and with a formidable array of top founders populating its ranks, YC has set rules and norms for startup investing to which traditional VCs have had to yield if they wanted to partake in the opportunities. These have consisted of a shaking up of all the old assumptions of what VCs did or could do, with the result that top VCs today will invest early and often in funding for startups right out the gate, that top VCs will invest in convertible notes and convertible securities (SAFEs) in ways that were once unthinkable, and, of late, that top VCs (and other investors) will have to abide by some founder-friendly rules about whether or not they are permitted to use high-pressure tactics in structuring their offers, in whether or not the are permitted to yank term sheets without consequence, and in many other areas as well.
I have no doubt that YC did all this for its own interests as well as for a broader goal of using its investments to further its idea of the startup ideal. I also have no doubt that this phenomenon is fueled by broader developments by which founders are now well-connected and able to know and understand what is going on in ways that founders in, say, the 1990s had no clue about. None of it would have worked otherwise. Yet, founders are now well-connected, they know a sucker-deal when they see it, and they know value when they see it.
YC does not offer value for everyone. Many founders have no desire to give up 7% of their company for a little cash and access to the YC network. But, for many (and especially younger) founders, the value offered is phenomenal. Hence, the huge YC draw of top-talented founders. And that is where the action is. If the traditional VCs want a part of that, they perforce must conform to YC's expectations and founder-friendly rules. And they have done so.
Top VCs will continue to have enormous clout. But it is no longer lopsided the way it was a decade ago and before. It is now far more balanced and one of the big reasons is that a different style of venture firm in the form of YC came along to set new standards that now govern a big part of how the game is played. YC rethought the rules of being a VC and did it radically differently. It has paid off. The venture business will never be the same again.
This is what happens when (as an industry) you don't treat people well, when you feel have the power to do as you please. Let me explain: pre-Ycombinator a lot of VCs would routinely either abuse or just simply ignore a lot of entrepreneurs. Someone can correct me but YC was a response to that. One reason everyone flocks to YC is because everyone knows that YC is fair and trustworthy. That's not the case anywhere else (at least back then).
They also have a relatively transparent application process. I think that means a more level playing field based on merits rather than on who you know.
It'd be interesting to see hard data on that, from speaking with various YC founders in recent batches it seems a lot of them had recommendations from YC alumni.
Back in the early days pg mentioned around 10-15% of the accepted class were referred but I wouldn't be surprised if that figure had crept up over time.
> One reason everyone flocks to YC is because everyone knows that YC is fair and trustworthy.
Another reason is that YC is the gold standard, and having that endorsement opens all kinds of doors.
But simply put, YC is a better mousetrap compared to the old-boy capital firms.
>>having that endorsement opens all kinds of doors.
This might be the most important of all things. People pay big money to get into Ivy Leagues because its assumed the smartest study there, and then come out even better. Access to a rich, powerful and well connected Alumni, which has a mutual interest in defending each other to keep the value of their network high is best thing you can ever have in your career.
Probably not many people get into YC for the initial money these days. Its just access to that network and the alumni.
> Another reason is that YC is the gold standard, and having that endorsement opens all kinds of doors.
Yes it does, but it actually should not. By becoming an endorsement YC loses a bit of its effectiveness and the eventual rate of success will probably decline measurably.
Ideally investors would properly investigate the companies they intend to invest in rather than to just use YC as a way to increase their probability of scoring a hit. That's just another variation on the 'dumb money' theme and the field as a whole will lose from such inefficient allocation.
It will put fewer wood behind more arrows. Even though YC companies are probably already over-valued it would be more efficient if VC capital would concentrate on those companies the VCs actually believe will succeed rather than to see these blanket investments in anything that moves that has been backed by YC.
It even matters to the founders.
As long as there is a glut of capital chasing these companies a number of companies that did not go through YC will likely be passed up on simply because they don't have the stamp of approval that YC offers.
This is a gap that might be large enough for a smart VC to exploit. Ignore the YC stamp of approval, treat all applications equally and invest in a couple of dark horses that did not make it to YC for various reasons (geography, timing, bad fit), but to have their application roughly around the same time as YC has theirs.
That way they can use the YC 'vetted' companies as the benchmark against which they can evaluate their batch of 'dark horses' substantially increasing the hit rate of the latter without having to compete with all the other investors in the YC batch.
Actually angel investing was the response to that, individuals who weren't wealthy enough to join a fund and become an LP but had enough disposable assets that if they put $50,000 - $1M at risk it wouldn't ruin their retirement if they lost it all.
One of the things that I haven't read about is what is the 'YC' of movies? In many ways the money in Hollywood is there but there isn't nearly the organization like there is at startup incubators. There are so many corollaries between the two environments I would expect something between the studios and Kickstarter to have emerged by now.
Individuals have a lot of sway in Hollywood. It's all star power. Money and talent flock to the stars, and by stars I include producers, writers and directors in addition to actors and actresses. They make money and are prestigious to work with, especially if the movie is successful. In addition to individual behavior there are also the various unions like the Writers Guild of America, the Screen Actors Guild, the Directors Guild of America and organizations like the MPAA and AMPAS and in television ATAS which all wield considerable influence and money. Though it is TV and not movies, Netflix succeeded because it played by their rules.
You can't just disrupt this because it's more than wealth, it's a culture that has been around many generations now and created film making what it is today. There's an incredible gravitational well that sucks all the incredible skill and talent found in the world right into Hollywood. It's not going anywhere.
You could argue its all 'star power' in the valley too, money and talent do seem to follow people who have a couple of big exits on their resume. One of the differences though is the artistic element. Engineering startups is an 'art' but it isn't the kind that brings out the 'artist temperament' as some refer to it.
I don't have enough real knowledge about how that gets done so I can't really say if such a thing could happen, but I do see a lot of similarities between Bay Area culture and So Cal culture which are both warped a bit by their respective economic engines.
YC probably most closely resembles the talent agency William Morris.
Nah. WMA is in the business of taking people who are already successful and making them richer. They are negotiators.
YC resembles a top-tier investment bank, like Goldman Sachs: they gussy you up for the road show, they introduce you to their very large network of investors, and they take 7%. And they get high prices for their clients because they (YC/Goldman Sachs) has a reputation for getting the best companies into the funnel, which is in turn based on getting high prices for their clients.
William Morris discovers and coaches talent. They take a management fee. They intro their talent to film makers who have money. They're really only looking for super stars, but they sign a lot of other people by mistake.
Angels may be better than VCs, but the thing about angel investing, besides say Ron Conway, is that they're not always guaranteed to be great either in terms of integrity.
I don't think traditional VC firms are competing with YC at all.
There are two "black holes" in venture capital right now. One black hole is YC + angel investment. When you're getting started, it's pretty much standard practice to go through YC and/or raise seed capital from angels to get your startup off the ground.
The other black hole are a few top VC firms (off the top of my head, a16z and Sequoia). These firms pretty much figured out that it's impossible to predict success, so they're putting large amounts of capital into companies that are already succeeding. They've essentially eliminated guessing; they can get away with it because they established themselves as the VC firms you go to if your company is succeeding (so they have no issues with deal flow).
Then there are traditional VC firms in the middle, who can actually operate by perpetually losing money due to a slightly weird wider financial climate and the incentives of their LPs (see http://pmarchive.com/truth_about_vcs_part1.html, http://pmarchive.com/truth_about_vcs_part2.html, http://pmarchive.com/truth_about_vcs_part3.html).
So everything is much more complicated (and much more interesting) than the original post would lead you to believe!
uhhh, I think you mean "funds" not "firms." Defining 3 regions and pigeon holing firms is too much of a simplification of VC markets.
Firms raise funds, that can target specific markets/verticals, as well as company size/maturity.
a16z is a firm. They have multiple funds, including a seed fund, surprisingly named "Seed" which competes directly with YC.
Some Firms have only 1 fund. Firms manage and guide their funds, and charge a management fee. While managing a fund is a largely personal intensive business, much like consulting, there are some economies of scale which is why many Firms will have multiple funds. This also further protects against risk.
YC and other accelerators are Firms, potentially with multiple funds, but all of their funds are at the low/angel end.
Having multiple stages of the process is perfectly ok. The risk is offloaded to those who can bear it. Small teams of very young people can take home run like risks by bootstrapping. YC diversifies the Angel risk by giving lots of advice and structure to large groups of firms. The top VC firms provide growth capital, but even there it's not about sure things. Many investments lose money, but it's not as risky so they can have relatively fewer investments with much bigger bets. By the time it's a so-called sure thing, firms have done their IPO.
Network effects at work. VCs will probably not find it amusing if - and of course when - they realize that they have been disrupted. But it is a funny kind of poetic justice.
Everything, even capital markets can be disrupted (or at a minimum greatly shaken up) by a dedicated player with a technological advantage.
And once the network effects kick in you're going to have a very hard time gaining back lost ground.
I predicted YC moving in on capital providers a while ago and I expect that trend to continue once YC has cashed out on their first batch of major hits. They'll be so flush with money that the only reasonable way to use it will be to do their own series 'A'.
Right now that's not in the cards and they should probably deny such a possibility as strongly as they could. But once the money is in they're going to be very much tempted to broaden the scope and become a two stage rocket even though there are obvious drawbacks to that strategy as well.
> They'll be so flush with money that the only reasonable way to use it will be to do their own series 'A'.
The other way to use that money would be to have gigantic batches. Remember, pg and sama have said that they're trying to build something akin to a university with Y Combinator. Using their money to do series A's instead (which is what other accelerators are already doing) would just be so conventional, and not what I'd expect from an organization as innovative as YC.
This. I'd think batches with 200 (500? 1000? startups) will come before Series A's. If only on principle.
With batches that large the positive effects of the 'classes' model will vanish, it will also require a much more efficient way of processing the applications and that will lead to (percentage wise) more rejections of good applicants.
YC is as good as they are because they really work hard on processing those applications and even though it is software assisted it is still to a very large extent handwork.
Yes, this leads to philosophical questions about the relative compounding of labor, creativity, capital and future-constraining financial instruments.
YC doesn't have anything like a monopoly on great startups. If investors can't find their own great startups they don't deserve to be successful as investors.
What all SV investors should be worried about is crowdfunding. Most of them don't have anything to offer beyond money and that doesn't count for much if users pay millions in advance.
Oculus took VC money but you can bet it was on incredibly advantageous terms due to their millions in kickstarter revenues. A16Z was merely the strongest among the weak and paid for the privilege of investing.
The fact that Oculus was immediately acquired for billions by a company Marc Andreessen sits on the board of is not necessarily a good outcome for the world. A fully crowdfunded Oculus may never had chosen that route.
Except a16z was their Series B investor, Oculus raised their Series A from a bunch of mid-tier VCs which implies it wasn't a hugely competitive round hence probably wasn't on particularly favourable terms.
By the time a16z invested Oculus had John Carmack as CTO and they already demoed to huge interest at E3. It was already a much later stage company by that point.
Their Series A was $16M at a likely ~$100M valuation. Incredibly successful by any standard and only possible because of crowdfunding.
How does Genius get away with copying an entire (paywalled) article with a single link back?
Perhaps the commentary is transformational enough to make it arguable legal, but it seems entirely wrong to me.
Would it be sufficient to add a Disqus widget to the article? If so, why couldn't reddit or HN repost entire articles? Perhaps The Information has licensed their content to Genius, in exchange for visibility and branded commenters.
In-place annotations are part of ongoing work at W3C (http://www.w3.org/2014/04/annotation/), and will allow bring-your-own-annotation servers. Genius.com wants to "annotate the web", making the site a possible future HN substitute. Does Genius.com plan to license guest posts, until such time as content providers enable 3rd-party annotations?
How does copyright work in a situation like this then? You're taking a paywalled (expensive paywall at that) article and posting it elsewhere. How's it not copyright infringement?
I'm guessing it'd be claimed as fair use because it's transformative.
Because of the annotations?
I don't use Rap Genius often, so I almost missed sama's responses.
Be sure to click on the annotations to see them.
I use Genius almost exclusively for its rap annotations, so reading news on this platform felt strange to me. While I can definitely see its merits for lyrics/poetry, I'm not sure how much I like it in this context. I think that expository/news articles should be written well-enough that annotations (other than hyperlinks, I guess) are unnecessary.
The point of this annotation was for someone who disagrees with the author to offer a point by point take down in the context of the original article.
You could understand the article (at least the view the author wants to promote) just fine without the annotation--the annotation provides a counterpoint that systematically undermines the premise of the article. [edit spelling]
Agree! I was going to reply to some of Sam's comments, but stopped because this is not at all what Genius was designed for and my reply to his comments wouldn't fit the UX.
Did you notice the comments button?
Ah, that's the first use of the annotations for this that I've seen. The only other "news" I've seen on Genius before was statements from Genius or a16z, and the annotations only provided more in-depth explanations of the text.
I'm of the opposite opinion. I loved it! The concept seems similar to Hypertext [0] (or what it was supposed to be). Would love to see how they handle first-hand commentary from multiple conflicting voices!
I actually found the UI excellent when reading this. You get to see counterpoints and clarifications inline, and you can see exactly what phrase or sentence is being addressed.
The only improvement I could see is if it was more prominent who is giving the verified annotations. It's listed twice at the top but they're easy to miss. Might be nice to have each person's avatars and names take up the side next to the first few paragraphs.
if I were a VC, I’d worry much more about Angel List than YC when it comes to A rounds
-- SamA
Completely agreed. Which pretty much kills the entire point of the article.
why not do A rounds? I agree regarding the signaling issue ( if you do A round for 3 companies, you are sending bad signal for the remaining ones ) - but what if you address/ mitigate the signaling issue?
I'm not sure how one is even supposed to know that Sam was the one writing the annotations. Is there even a way to see who wrote them?
Click on the annotation and then click "Authors" under the text.
Thanks for pointing this out. @sama's pitch perfect on his notes here.
Worst user interface on the planet.
Insanely laggy in chrome on an S5. Really no excuse for that when I'm only on the page to read a few paragraphs of text...
Works fine on an S4 in Chrome as well.
Works fine in Mobile Safari.
It's hard to believe credible venture institutions would be upset by these moves. I can't speak on specific deep-pocketed VCs who offer nothing more than cash -- which is not what most startups need. However, firms that offer nothing more have their fodder here to complain here as they'll have to rely on real value also to keep them in play. They'll be forced to step it up. Reminds me of Jay Z's quotes on sports agents:
http://profootballtalk.nbcsports.com/2013/07/12/jay-z-says-h...
"So it shouldn’t be surprising that venture capital firms are starting to worry that YC might start elbowing into the capital allocation part of the businesses."
It seems like YC currently doesn't have the whole Investor Relations infrastructure (or mindset of dealing with pensions) to get into the mainline VC business. I do think they are protecting their franchise against poor VC behavior though.
This “signaling issue” is a huge problem, by the way—accelerators that do the Series As for their top 3 companies deeply wound all the rest. - Sam Altman
How is this different from a VC firm like Andreessen doing Series As for their top 3 seed companies? Isn't signaling part-and-parcel of the startup economy? Why should YC be worried about signaling when a firm like Andreessen isn't?
It is an issue. It's even worse for big VCs because they have the funds to do the follow-on for any seed company they think is doing well. So it's not just a signal of being "top 3" it's a signal of being good.
[There are other reasons why VCs chose not to do follow-on, such a conflicts-of-interest, disagreements on valuation, etc. but any other VC you speak to will ask you why your seed investor isn't following-on]
Founders will often take money from seed-only funds or will take money from several multi-stage funds in order to mitigate the signalling risk.
Because YC is involved with a startup for 3 months far more intimately in a very early and telling stage. a16z, with all it's due diligence, won't know a startup as well as YC does at that stage.
Genius seems to be getting a lot of hate here and I'm not sure why. The UI is certainly odd. To me, it feels like the design is trying so hard to be futuristic and "cool" that it trips over itself and loses some ease of use.
But come on, you can get over that, and to me this was the first use of Genius I've come across where I thought "Damn that was cool, I'll have to use this for more than the occasional lyric."
This was really cool to me because it provided an interactive forum for multiple relevant parties (Sam Altman and Marc Andreessen) to have a debate. I'll get over the funky UI for that content any day.
I hope genius isn't the future of writing, that was painful to read.
I couldn't even get through it
I think VCs are used to being the only guys on the block and don't like that they aren't fully in control any more. It's the same thing that has happened to Wall St. But different in that the VCs had even more control and some back room deals going. YC isn't the the real issue. They are providing a good education and strong ideas which help to prove them to be the best of all the accelerators out there today.
I really like to see one day YC goes for an IPO of its own. As long as YC keeps it's process transparent, it is really hard to beat them. As you grow YC, keep it fair and honest. Don't give into any bias.